April 15, 2010
Don’t Walk Away
Until recently, owning a home was the wealth-building move. These days, many homeowners are contending with more mortgage than the home is worth, joblessness, and other financial challenges and deciding to simply walk away from a dream home turned nightmare.
“We were hanging on, but for what?â€ asks Clovis, California, homeowner George W. Hicks, 64, echoing the thought process he and his wife, Mae, 62, went through in 2009. Three years earlier, the Hickses paid $555,000 (borrowing $380,000) for their home, chosen because it would be big enough to accommodate their daughter and grandson.
But 2009 turned into a calamitous year for the Hickses. Their home dropped in value from its peak of $638,000 to around $320,000. It wasn’t simply that they were “under waterâ€ in their mortgage. The Hicks’s investment portfolio had plummeted the year before and was generating only a tepid recovery. Making matters worse, both George and Mae were diagnosed with cancer. At the time, a “walk awayâ€ seemed like a good option. A strategic default, or “walk awayâ€ as its known colloquially, is different from the average foreclosure. It involves a homeowner who can afford to continue paying his mortgage but consciously chooses not to.
“We were getting by, paying everything on time. But the house was huge and so were our utility bills. At the end of the month, there was nothing left.â€ George explains. “We realized that, eventually, everything would come crashing down. We had to decide whether to walk away or find some other way to get out from under this.â€
Walking away from the home would be difficult for George. He prided himself on “a lifetime of doing things exactly the correct way.â€ Though the stigma to walking away may be diminishing as foreclosures increase, many homeowners still attach guilt or shame to the idea. Like the Hickses, they may feel duty-bound to honor their obligations. “Even though there was no monetary upside in it for us, we gave our word, and our word meant something,â€ says George.
In that sense, he is like more than 80% of U.S. homeowners who believe “it is morally wrong to walk away from a house when one can afford to pay the monthly mortgage,â€ according to Moral and Social Constraints to Strategic Defaults on Mortgages, a University of Chicago and Kellogg School of Management, Northwestern University study. But studies also show that many homeowners have a breaking point at which “strategically defaultingâ€ on their mortgage becomes a serious option.
Who Walks, and Why?
The Hickses are not alone. About a quarter of U.S. mortgage holders (11.3 million homes) are currently in a similar situation. According to mortgage data firm First American CoreLogic, when homeowners reach the point where they owe at least 25% more than the home’s value (for example, owing $375,000 on a home now worth only $300,000) they become just as willing to walk from their own homes as an investor. For some, the final straw is a serious illness or job loss. For others, there’s a critical point at which dwindling or negative equity turns walking away into a worthy consideration.
In the states hardest hit by the mortgage crisis (Arizona, California, Florida, Nevada, and Michigan) mortgage holders have an average of 40% negative equity–and no clue if their homes’ values will ever fully recover. It’s no wonder that 26% of U.S. foreclosures are estimated to be strategic defaults.
The national stalemate between banks and borrowers over loan modifications and principal balance reductions also influences homeowners considering a default. David Daniel, a certified mortgage planner specialist in Oakland, California, finds that the average potential “walkerâ€ is exasperated after waiting six months or longer for their lender to respond to a loan modification request. “Then they contact me and want to talk about refinancing or, as a last resort, walking away.â€ Antioch, California, real estate agent Tique Lee Caul sees the same thing in the underwater homeowners she counsels: “Some people feel screwed that they paid double, sometimes triple, what their neighbors are paying now. Some feel that the banks were rescued but are unwilling to work with borrowersâ€ to reduce their payments or principal loan balances.
Consider the Consequences.
Walking away can create a whole host of problems for borrowers. George Hicks researched his options and discovered that the credit consequences are severe. The “walk awayâ€ would ruin his valued 840 credit score, prohibiting him from buying another home for roughly five years. “I wanted to be able to have the credit to do whatever we needed to do in our final days,â€ notes Hicks.
Nate Anderson, a licensed real estate agent with offices in Chicago and Philadelphia, also warns clients to be aware of the looming possibility of a “deficiency judgment.â€ That’s when the lending bank seeks to recover the difference between the balance left on the mortgage and the fair market value of the home.
Anderson says that in many states, “A lender can and will sue a homeowner for a deficiency judgment.â€ Those who walk away may be exposed to a deficiency lawsuit for as long as six years following the foreclosure in some states. Accordingly, Anderson advises homeowners in mortgage distress to instead work through their mortgage troubles with a real estate attorney “so that you are completely off the hook with the lender.â€
The legal ramifications of a walk away vary from state to state. Even in the few states where borrowers can’t be sued by mortgage lenders, walking away can expose a homeowner to significant state income taxes if the state’s tax laws count debt forgiveness monies as income. So says California tax and real estate attorney and CPA Scott Haislet, who has counseled more than 200 homeowners on their personal mortgage crises since about 2007. Haislet also points out another big misconception homeowners have regarding a walk away: that both first and second mortgages will be extinguished if they default on the home. Rather, Haislet explains, the standard scenario is that the second mortgage simply becomes an unsecured loan, the balance of which the lender can sue the homeowner to collect up to four years following the foreclosure, under California law.
Many homeowners who consider walking away eventually decide to take another route. Those include negotiating a loan modification, a short sale, or a deed-in-lieu of foreclosure–where the borrower hands over the deed in exchange for the bank extinguishing the debt.
A member of George Hicks’s church purposely defaulted on his home and regretted the devastating credit consequences. The man cautioned the Hickses not to do the same. So instead, George and Mae opted for a short sale. The process turned into a drawn-out battle with their lender, but in the end, the home sold (for $315,000). George Hicks was able to move his family. The short sale left both George and Mae with credit scores just above 700, lower than they’d like, but still well above the national average of 671.
Caul finds that very few clients elect to walk away after she lays out their options. “Folks usually are willing to fight rather than to just give up when they know someone cares enough to work with them,â€Â says Caul. Likewise, the Hickses credit their real estate agents for helping them through the nearly eight-month short sale process. They were able to move their family, and they’re glad they didn’t completely wreck their creditÂ by walking away. After enduring their own personal mortgage crisis, the Hickses have also completed a round of cancer treatments. Says, George: “We’re going to be just fine.â€
Tara-Nicholle Nelson is a real estate broker, attorney and author of two real estate guides. Tara is the Founder and Chief Visionary of REThinkRealEstate.com.